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Bank capital rules should be overhauled to ensure enough capital is held against potential trading losses and there should be tougher oversight of banks' trading valuation and risk management systems, the UK's Financial Services Authority said on Wednesday.

The FSA's proposals, outlined in a new discussion paper, are a response to the conclusion by regulators around the world that banks and other financial firms didn't adequately account for their trading risks which meant they didn't hold enough capital to survive financial turmoil.

"The financial crisis has highlighted that, for trading activities in particular, an over-reliance on the principles of efficient financial markets can lead to severe consequences when risks are misunderstood at a system-wide level," said Paul Sharma, FSA director of prudential policy.

"The balance needs to be redressed to ensure that risks posed to the system as a whole are more adequately reflected in the structure of prudential regulation," said Sharma.

The FSA said it wants responses to its proposals from interested parties by November 26 and that feedback on these opinions will be provided in the first half of 2011.

The authority said that, in the past, banks have valued trading positions in different ways which means some methods are more robust than others. Similarly, they have used a variety of risk management and modelling systems.

The UK regulator's proposal to tighten rules governing trading activity standards comes ahead of efforts by regulators around the world to produce harmonised standards for banks to manage their trading risks and allocate enough capital against them.

The Basel Committee on Banking Supervision, the global bank rule-setting body, plans to introduce new rules by the end of 2011, ramping up the amount of capital banks need to hold against their trading activities. The FSA said the result will be that large banks hold more than three times the amount of capital they currently do against trading positions.

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The rules will, among other things, force banks to use more stringent stress tests on their market assumptions when calculating how much capital they need using internal models. They will also introduce capital charges for securitisation trades held in the trading book rather than just in the banking book.

The Basel Committee has also, however, launched a fundamental review of bank trading activities which will mirror the issues dealt with by the FSA consultation paper, the UK watchdog said.